The Lion sleeps, but will someone be crying over spilt milk?

Food and beverage company Lion has announced that it does not currently intend to sell its shareholding in Victorian dairy company Warrnambool Cheese and Butter to Canadian dairy company Saputo, sparking speculation over Lion’s value propositions for selling or retaining its shareholding in WCB.

If Lion were to sell its share of WCB to Saputo, Saputo would reach the 90.1 per cent share mark, which would enable it to compulsorily acquire outstanding shares and make WCB fully-owned. This would also mean accepting WCB shareholders get the final increase in the Saputo offer price to $9.60 per share.

But the ongoing trading relationship that Lion has with WCB may be more important to Lion than any gain from selling its WCB shares. Lion acquired a 9.99 per cent shareholding in WCB in November 2013, saying it “had enjoyed a close relationship with WCB over many years” and that WCB played an important role in Lion’s cheese business. Lion said it considered its stake a “continuation and strengthening of this relationship”.

As previously noted by Australian Food News, WCB manufactures cheese for Lion for Lion’s well-known Australian brands such as Coon and Cracker Barrel.

Given the mounting speculation about Lion’s dairy business being available for acquisition (its dairy brands include Pura, Dairy Farmers, Farmers Union, Dare, Coon, Yoplait and Fruche) its Japanese owner Kirin Holdings would want to preserve the value of the Lion business and not devalue it through the loss of a profitable aspect of its current operations.

What view of the rumours?

Rumours of Kirin putting up Lion Foods dairy division in Australia for sale may have eased since August 2013 when Moody’s Japan K.K. revised Kirin Holdings Company’s outlook to stable from negative and affirmed all of its existing ratings, including the A3 long term issuer rating.

The change in outlook was prompted by Kirin’s debt repayment with proceeds from asset sales and growth of its international businesses that offset the weakness of its domestic business. The negative outlook was put in place due to concerns on Kirin’s expansion into Brazil where it had limited business expertise, through a debt-funded acquisition that increased leverage in late 2011.

According to rating agency Moody’s Japan, Kirin’s A3 rating reflected its competitive position in beers, soft drinks and dairy products in Japan and Australia, its well-diversified product and business portfolios (including a small but highly profitable pharmaceuticals business), its healthy liquidity, and its commitment to reduce debt leverage as evidenced by the recent repayment of debt with proceeds from asset sales. At the same time, the rating is constrained by Kirin’s still-high geographic concentration in the competitive and mature domestic market and limited growth prospects of the domestic beer Japanese market, which is Kirin’s largest business.

About half of revenues come from Kirin’s domestic beverage business, 30 per cent from its international beverage business, and the remainder from the pharmaceuticals business (of which nearly 80 per cent of the Business is domestic).

While still predominantly domestic, Kirin has been increasingly diversifying geographically through its businesses in Australia and Brazil. Further, similar to many Japanese corporates, Kirin’s margins are thin compared to globally rated peers.

Nonetheless, the reported view that the Lion dairy brands in Australia will be on the market still persist. Would Bega Cheese or Murray Goulburn be very interested? Probably. Would Fonterra oppose an acquisition by those two? Yes. With so many vested interests at stake, it would require lots of spilt milk and some intricate unravelling of eggs in an omelette to sort out a few Australian dairy industry interlocking complexities, but that does not mean it cannot happen.